Something is rotten in the state of Denmark

In Shakespeare’s play, Hamlet, Marcellus states that something is rotten in the state of Denmark, which implies that all is not well. This is true of the whole structure of the banking industry currently, the financial services industry and the corporate world, globally.

The state of the world’s banking industry is pathetic, thanks to many factors including the declaration of banks as TBTF ‘too big to fail’ (which allows them to do stupid and dangerous things, on the assurance that they would be bailed out), the bouts of quantitative easing far beyond the point where it was essential, and, yes, also the compensation packages. When an investor makes a bank deposit he becomes merely an ‘unsecured’ creditor, near last in line if the bank goes bust.

TBTF banks are bailed out by governments pumping in taxpayer money, in the case of the TSTM (too small to matter, my coinage) banks, they are ‘bailed in’. Depositors lose their deposits, overnight.

The government has a scheme for ‘deposit insurance’ but this is a maximum of ₹1 lakh. This limit has never been adjusted for inflation (unlike salaries of MPs).

Four TSTM Italian banks have already been ‘bailed in’. Elderly and sick Italians are resorting to suicide. Other depositors have started withdrawing from TSTM banks. A failure of Italian banks could well trigger a European banking crisis.

A far bigger bank, Deutsche, is also deep in excrement. It has built up a gross derivative exposure of $46 trillion, over seven times German’s GDP. Angela Merkel has refused to bail out this TBTF bank. DB raised $1.5 billion by issuing five-year debt paper at junk bonds yields, around 300 basis points over Treasuries. Should Deutsche collapse, it would most certainly trigger a major crisis.

The root of the problem is the quest to become ever larger. This, in turn, is driven by pressure from institutional shareholders for it, and aided by the structure of compensation packages for top management, whether of companies or banks.

So if an investor puts money in a bank, his saving is protected only up to ₹1 lakh. The bank can seize the rest of the money if it invests that money imprudently or, as happened earlier, directed by politicians to their cronies.

What about equity investments?

Top corporate managements are also, under pressure from large institutional holders as well as encouraged by their stock options, taking on foolish risks. We saw a reputed company like Volkswagen faking emission tests, simply to boost profits, and thus, market cap.

Samsung has, last week, withdrawn its Note 7, which burst sporadically into flames. This has burnt a $17-billion hole in its market cap in one day! There is no way for an individual investor to beat large institutional ones in the exit race. Individuals do not have algo trading, nor the resources to. Similarly, Swedish telecom major Ericsson lost $3.5 billion in a day in market cap after poor results.

It is essential for governments to focus on protecting the individual investor from fraud and from a languid judicial system that doesn’t.

(The writer is India Head, EuroMoney Conferences. The views are personal.)

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